After having tried unsuccessfully for many years to get the Union ministry of finance and the Reserve Bank of India (RBI) to agree on using a part of foreign exchange reserves to finance infrastructure, the Planning Commission has now mooted the idea of a sovereign wealth fund (SWF).
The idea is not new, either here or in global financial markets. But it’s unique to the extent that the SWF is proposed to be set up by a country that not only has a sizeable current account deficit but is also resources poor and has a huge and growing resources deficit.
Over the years, SWFs have been set up, especially in Asia, to deploy surplus foreign exchange reserves accumulated by commodity exports. Through these SWFs, surplus foreign exchange reserves have been used for active profit seeking along with passive liquidity management that central banks use them for.
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In India, an SWF is needed to leverage reserves for overseas asset buyouts, especially energy and mining assets, to reduce the natural resources deficit that the country is facing.
In the process, it will mitigate high-energy costs, and reduce the massive raw material dependency of the country. There are three aspects to such an SWF. First is its size. The Planning Commission has proposed that the initial corpus be $10 billion (Rs 47,500 crore).
RBI will provide $5 billion from the foreign exchange reserves for the fund. The remaining $5 billion will be pooled by resource-rich public sector units, essentially making it a government controlled fund.
If the intention of the SWF is to compete for energy assets, then the proposed corpus is nothing more than an embarrassment. China has a number of SWFs that cumulatively add up to around $1.3 trillion and has made energy investments of $1.7 trillion in the last seven years.
The size of its SWFs is about 45% of its total foreign exchange reserves. Compared with this, RBI’s proposed contribution of $5 billion to the SWF is just 1.6% of the total reserves of $320 billion. Clearly this is inadequate and excessively conservative. To make a difference, India’s SWF should not be less than $50 billion.
Second is the structure of the SWF in terms of ownership as well as in terms of asset allocation. Given the extent of private sector participation in the energy sector—almost 45% of the total refining capacity in India is private—it makes sense to explore the ownership angle a bit. Should the SWF be 100% government of India “owned” and “managed”, like that of China, or should one look for a variant? Owned by the government but managed by the private sector? Or, a more structured public-private partnership to target specific assets abroad?
The idea of having a majority government stake and a minority private stake in the SWF can work. To start with, a two-thirds government and one-third private sector ratio can be looked at for the development of the fund. This will reduce the monetary exposure of India’s foreign exchange reserves and also reduce the fiscal deficit in budget mandates of the concerned ministries.
A private-public partnership can be modelled on the lines of the Iran Oil Stabilization Fund which began as an SWF to act as a stabilizer against fluctuating oil revenues but has now been converted into a national development fund.
This $30 million fund extends 50% of its financial corpus and facilities to private, cooperative and non-governmental sectors in an effort to promote domestic and foreign investment.
Further, as regards its asset allocation, given the macroeconomic conditions and private sector requirements, India’s SWF needs to be an asset specific fund and not a generic one. So unlike most of SWFs which invest in assets in services, finance, hotels and restaurants; transport, storage, and communications, the Indian SWF must operate exclusively in the energy and raw material space.
The investment style also will have to be different from the run of the mill SWFs. The objective of the SWF should be to acquire and expand Indian energy assets abroad. There are two principal models that will work for the Indian requirements; first is a pure asset buyout. However, an asset buyout of natural resources can become a liability. So, a part of the fund can be deployed for taking equity stakes in asset holding companies.
This has two benefits; first, it will help mitigate the risk of the stake holder in the event of the asset turning bad because of depletion of resources or political volatility in the sovereign country. In adverse circumstances, the equity stake can be liquidated rather than holding on to a poor asset. Second, it is more liquid, which can give RBI some comfort. The fund can have a 30:70 ratio of deployment of capital to finance asset buyouts and buy equity stakes. The equity needs to be structured in such a manner than there are corresponding and proportional rights to the assets rather than monetary profits.
Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at firstname.lastname@example.org